Ted Allrich is the founder of The Online Investor and author of the just released book: Comfort Zone Investing: Build Wealth And Sleep Well At Night. In this weekly column, he'll offer advice to investors who are just getting started.
Most investors buy stocks by simply putting in a market order and hoping for the best. That means they'll pay whatever the offer (or ask) price is for the stock. There are a couple of things wrong with this approach. There's a much better way to buy stocks that saves money and makes more money when a stock heads higher.
Here's the problem with buying at the market: you're paying a price set by someone else, and you may not buy all your stock at the same price. Furthermore, if you're looking to buy 1000 shares and buy it all at once, you're betting a stock is at its low, that it will go up from your entry point. Most likely, that's not the case.
Let's start with the price of the stock. If you've done your homework, you should determine what you're willing to pay for a stock. Whether that's from fundamental or technical analysis or both, you determine what's a fair price. Once you know that, and are comfortable with your price, put that price in as a bid. Most likely, it's not where the stock is trading when you decide to enter your order. So put in your order below the market and wait for the stock to come to you.
If the stock is at your price, then put in a "limit order" so you won't pay more than your price. The limit order says you will only pay one price for a stock. Sometimes that means you won't get all your shares, but most of the time you will.
Second, don't buy all the stock at once. Divide your order into at least 2 or 3 orders. In the above case, if you wanted to buy 1000 shares, buy only 500 at your first entry point. Then look to add to your position if the stock goes lower, which in most cases, it will. To assume you can pick the bottom for a stock is somewhat arrogant. Nobody is consistently that smart, (or more aptly, lucky). Give yourself some room for error and add to your position if the stock goes lower. If it doesn't, you've got half your position in place and will benefit from your initial stake. Even if you're looking to buy 200 shares, split the order into 2, 100 share lots.
Another consideration: if you don't like odd lots (buying stocks in lots of less than 100 shares), then you can put in the order as "All or nothing", meaning the specialist or market maker has to fill your order in full or not at all. Sometimes this means you won't get your stock because there aren't enough offered to fill your order. Most of the time you will, however.
As mentioned earlier, when you put in a market order to buy a stock, you are giving the specialist or market maker the signal to pay any price for the stock. The first 100 shares will be filled at the current offer price, but if it's a thinly traded stock (not many shares trade every day), you may get 100 shares at the offer side, then the price will move up, not by a little, but by a lot. If your order isn't filled, then the market maker or specialist will buy the next 100 shares at the higher price, then he/she can move the market higher and fill the next 100 shares. And so it goes until you've bought all your stock, at ever higher prices.
In a nutshell, you've given up control on buying a stock when you enter a market order. You're saying you want stock at any price so just buy it. If you use prices that you determine are fair, have patience and wait for the stock to come to you, then you control how much you buy and at what price. If you split your orders so you don't buy a position all at once, you will lower your cost and make more money when the stock rallies.
